ost investors arefamiliar with tradi-tional asset classessuch as stocks andbonds. However, adiversified portfo-lio may also include alternativeinvestments (AI) such as PrivateEquity, Hedge Funds, Real Estateand Commodities. By combiningthese alternatives with tradition-al stocks and bonds, investorsmay be able to improve theirrisk-adjusted returns over thelong term. AI expands the oppor-tunity set by investing in abroader range of markets andsecurities, including illiquidassets. In addition, AI is able toemploy non-traditional invest-ment strategies such as shortselling, leverage, derivatives andconcentrated stock positions.

Here is a broad framework to
understand the exciting world of
alternative investing. In general,
they are four major styles of AI:

1) Credit-oriented AI strategies
seek stability and consistent
returns and may also offer an
income stream. 2) Diversifying AI
strategies offer low or negative
correlation to traditional stocks
and bonds and hence seek a differentiated source of return.

3) Equity and Growth-Oriented
AI strategies seek capital appreciation and enhanced returns and
may utilize public and private
equity as well as credit instruments. This is typically considered the most aggressive AI style.

4) Multi-Strategy AI offers a mixof the above three categories tohelp achieve investor goals. Theoptimal allocation of AI in a port-folio depends on an investor’srisk tolerance, time horizon andliquidity needs. In general,investors need to pass an incomeand asset qualification process tobe able to invest in AI.

Let’s examine the benefits.

First AI helps diversify a traditional portfolio by seeking superior risk-adjusted returns over
the long term. As you see from
the exhibit below, hedge funds
have provided downside protection during equity market corrections. Incorporating strategies
that lower or introduce negative
correlation to equities and bonds
helps to reduce the overall risk of
a portfolio. Investors need to
understand the specific goal of
adding AI to the mix — risk
reduction, return enhancing or
diversifying.

Investors with patient andlong term capital may consideran allocation to Private Equity(PE). Historically PE has provid-ed a higher return than publicequity and bonds. PE offersinvestors an “illiquidity premi-um” — a higher potential returnfor committing capital for a longperiod, typically seven to 10years. In addition, many PE man-agers take an active role in advis-ing or running the companiesthey invest in. There are severaltypes of PE strategies but theygenerally fall into four categories.

Leveraged buyout PE strategies
typically acquire companies
using borrowed money and seek
to streamline the operations of
the companies they invest in and
monetize their investments
through a strategic sale or an initial public offering (IPO). On the
hand, venture capital PE strategies invest in start-up companies
that have attractive growth
prospects. This area is considered especially risky as the
underlying businesses may compete in nascent industries or
have unproven business models.

Special Situation PE strategiesseek to invest in distressed situa-tions by purchasing equity ordebt in the underlying company.

Unlike a mutual fund or ETF,
investors in PE are limited partners (LP) in a partnership structure. The expenses are significantly higher than traditional
investments and investors typically expect superior returns. In
addition to a management fee,
the General Partner (GP) may
have a profit sharing allocation
or an incentive fee. The committed capital is typically drawn
over a three- to five-year period,
referred to as the “investment
phase.” As the GP exits the
investments, investors receive a
cash distribution. Unlike traditional mutual funds, these are
not reinvested back in the fund.

A typical fund may have a three-to five-year draw down periodand distributions generally beginin the fourth or fifth year. This isalso referred to as the “harvest-ing phase.” These are broadparameters; investors shouldcarefully examine the prospectusto understand the terms of theoffering. It is important to notethat PE is not freely tradable onthe public markets and hence areilliquid in nature.

Over the past few decades,
major endowments such as Yale
and Harvard have allocated a significant percentage of their
investments to PE and AI in general. We suggest consulting your
financial advisor to determine
whether you qualify and determine your suitability for this type
of investment.

Raj Sharma is Managing Director in Merrill
Lynch’s Private Banking and Investment
Group. He has been named to Barron’s
“America’s Top 100 Advisors” in 2017 for the
fourteenth consecutive year* and named
Massachusetts Top Financial Advisor on
Barron’s “Top 1,200 Financial Advisors” in
2017 for the ninth consecutive year**. Raj
can be reached via email
raj_sharma@ml.com

*Source: Barron’s "America's Top
100 Advisors" list, April 17, 2017. For
more information about the selection
criteria, go to Barron’s Top Financial
Advisors page. Barron’s is a trademark of Dow Jones & Company, Inc.

No investment program is risk-free, and a systematic investment
plan does not ensure profits or protect against loss in declining markets.

Any investment plan should be subject to periodic review for changes in
your individual circumstances, including changes in market conditions or
your financial ability to continue purchases.

Investing involves risk, includingthe possible loss of principal. All opin-ions are subject to change due tomarket conditions and fluctuations.

Some of the risks involved with equities include the possibility that the
value of the stocks may fluctuate in
response to events specific to the
companies or markets, as well as
economic, political or social events in
the U.S. or abroad. Bonds are subject
to interest rate, inflation and credit
risks. Investments in high-yield bonds
may be subject to greater market
fluctuations and risk of loss of income
and principal than securities in higher
rated categories. Investments in foreign securities involve special risks,
including foreign currency risk and
the possibility of substantial volatility
due to adverse political, economic or
other developments. These risks are
magnified for investments made in
emerging markets. Investments in
high-yield bonds may be subject to
greater market fluctuations and risk
of loss of income and principal than
securities in higher rated categories.

Investments in a certain industry orsector may pose additional risk dueto lack of diversification and sectorconcentration. AlternativeInvestments are speculative andinvolve a high degree of risk. Aninvestor could lose all or a substantialamount of his or her investment.

Alternative investments are
intended for qualified and suitable
investors only. Alternative
Investments such as derivatives,
hedge funds, private equity funds,
and funds of funds can result in higher return potential but also higher loss
potential. Changes in economic conditions or other circumstances may
adversely affect your investments.

Before you invest in alternative
investments, you should consider
your overall financial situation, how
much money you have to invest, your
need for liquidity, and your tolerance
for risk.

Alternative Investments are speculative and involve a high degree of
risk.

Alternative investments maytrade on a leveraged basis whichincreases the risk of loss.

Performance can be volatile.

An investor could lose all or a
substantial amount of his or her
investment.

The use of one or a small number
of fund managers applying one set of
allocation procedures could mean
lack of diversification and, consequently, higher risk.

There is no secondary market for
investor’s interest in alternative
investments and none is expected to
develop.

There may be restrictions on
transferring interests in the alternative investments.

High fees and expenses, including
performance fees payable to the
manager, may offset trading profits.

A substantial portion of the trades
executed by the underlying managers may take place on non-US
exchanges.

In addition to the foregoing risks,
each alternative investment fund is
subject to its own strategy-specific or
other risks. You must carefully review
the offering memorandum for any
particular fund and consider your
ability to bear these risks before any
decision to invest.

In addition to the foregoing risks,private equity fund investments aresubject to the following additionalrisks:Private equity investments involvesignificant risks and are typically illiq-uid on a long-term basis and mayrequire a holding period of at least 8to 12 years. Underlying private invest-ments may be difficult to value.

Private equity managers typicallytake several years to invest a fund’scapital. Investors will not realize thebenefits of their investment in thenear term and there will likely belittle or no near-term cash flow dis-tributed by the fund during the com-mitment period. Interests may not betransferred, assigned or otherwisedisposed of without the prior writtenconsent of the manager.

Private equity funds may make a
limited number of investments, and
such investments generally will
involve a high degree of risk, such as
start-up ventures with little or no
operating histories. In addition, funds
may make minority equity investments where the fund may not be
able to protect its investment or control or influence the business of such
entities. The performance of a fund
may be materially impacted by a single investment.

A private equity fund may obtain
rights to participate in, or to influence,
the management of certain portfolio
companies, including the ability to
designate directors. This or other
measures could expose the assets of
the fund to claims by a portfolio com-